Liabilities — Amendments to IAS 37
The purpose of this session was summarise the current status of the project, to identify unresolved issues and to agree on the extent of further work required on these topics in the IAS 37 project.
Distinguishing a liability from a business risk
The Board reaffirmed its previous decision that the occurrence of a past event (i.e. not a potential outflow of economic benefits) distinguishes a liability from a business risk. A present obligation arises after something has happened. In contrast, a business risk is something that might happen in the future as a result of conditions that exist on the balance sheet date.
The Board then discussed a related issue with regard to the definition of a liability. The staff noted that the phrase 'little, if any, discretion' used in paragraph 13 of the ED to describe when and why an entity has a present obligation might be ambiguous and asked the Board whether this term should be replaced by more emphatic phrases such as 'irrevocably committed', 'no discretion' or 'something an entity cannot avoid'.
One Board member noted that the main problem with the phrase 'little, if any, discretion' is that it is sometimes applied to answer the question whether the outflow of resources can be avoided.
Overall the Board was not convinced that a more emphatic phrase would make things better and decided to keep the phrase 'little, if any, discretion'.
Stand ready obligations
The Board reaffirmed that a stand ready obligation must satisfy the definition of a liability and that the term 'stand ready obligation' is just a label for situations where an entity has an unconditional obligation associated with a contractual obligation (for example, product warranty and written options).
The staff presented revised wording for paragraphs 22 to 26 of the ED reflecting the Boards tentative conclusion. Subject to editorial changes the Board agreed to the proposal.
Existence of a present obligation The Board identified three general situations when uncertainty about the existence of a present obligation might arise:
- (a) Did a past event occur?
- (b) How does authoritative guidance (including statute, law, contract and regulation) apply to known facts?
- (c) In the absence of legal enforceability, do cumulative events and circumstances provide sufficient evidence to confirm that a present obligation exists?
Situations (a) and (b)
The Board noted that an entity must use judgment to determine whether a present obligation exists and that the evidence an entity considers and the relative weight assigned to each piece of evidence will depend on the individual facts and circumstances of each case. Subject to some editorial changes it was decided to give additional guidance on situations (a) and (b) by providing indicators such as:
- The entity's own experience with identical or similar items
- The experience of others with identical or similar items
- The opinion of experts
- Additional evidence provided by events after the balance sheet date about conditions that existed on the balance sheet date
- Any evidence of a potential breakdown or weakness in an entity's internal controls (for example a letter of complaint, the start of legal proceedings or an internal audit report).
One Board member observed that the purpose of the indicators is to indicate whether a certain event that has happened leads to a liability rather than solely whether an event has happened, and that this should be clarified in the standard. At this point the Board redeliberated the 'hamburger example'. The Board discussed this example in March and May 2007 but did not reach a conclusion whether:
- The sale itself gives rise to a present obligation and all available evidence is used to reflect uncertainty in the measurement of that present obligation.
- A present obligation arises only when the hamburger is contaminated and all available evidence is used to determine whether or not a present obligation exists.
One Board member recalled a previous discussion, in which the Board was content to conclude that performing operations in a hospital did not create liabilities, only when an operation went wrong. There was a strong analogy between the examples. However, Board members noted that the staff had made real progress towards solving a very real problem in accounting and encouraged them to spend a bit more time to see whether a definitive solution could be developed. The Board agreed to ask the staff to investigate the issue further.
As agreed at the May 2007 meeting the staff explored the following three options to address uncertainty in the ED:
Option 1: Limit the recognition of constructive obligations to those a court could enforce;
Option 2: Recognise both constructive obligations that a court could enforce and constructive obligations that are enforceable 'by equivalent means' and explore the meaning of 'by equivalent means';
Option 3: Option 2, but use the explanatory text already in paragraph 15 of the ED as a proxy for explaining 'by equivalent means'. The staff proposed the following revised wording:
'In the absence of legal enforceability, particular care is required in determining whether an external party has a right to call upon an entity to act in a particular way. In the case of a constructive obligation, this will only be the case if:
- (a) the entity has indicated to other parties that it will accept particular responsibilities;
- (b) the other parties can reasonably expect the entity to perform those responsibilities; and
- (c) the other parties will either benefit from the entity's performance or suffer harm from its non-performance.'
The Board agreed to proceed with option 3. The Board draw particular attention to the phrase 'an external party has a right' that is, any kind of economic compulsion would not meet the criteria of an obligation.
The 'more likely than not' recognition criterion
The Board was asked whether an explicit 'more likely than not' criterion should be included in any final standard.
The Board was nearly equally split. Board members against including the criterion argued that assessing whether a present obligation exists is a judgemental, not a mathematical issue. In addition, including the criterion would create a 'safe harbour' that would help preparers to avoid tough decisions. Those Board members who favoured including the criterion would include it, provided that it was not seen as determinative.
The Board will continue its deliberations at a subsequent meeting.